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Consultation Begins Over Possible UK Corporate Governance Reform

The Department for Business, Energy & Industrial Strategy (BEIS) has recently published a Green Paper on options for future corporate governance reform. The Government’s stated objective is to put in place “the right checks and balances within big business to strengthen decision-making and accountability”. Whilst the much trailed idea of compulsory employee representation on boards appears now to have been dropped, the Green Paper sets out a number of potential reforms which are under consideration. It is not necessarily the case that formal legislation will result as it is made clear in the Green Paper that the introduction of non-legislative standards for business may be preferred.

The Green Paper contains a range of significant proposals in three main areas:

shareholder influence on executive pay - BEIS considers that there is a public perception that executive pay is disconnected from the pay of ordinary working people and the underlying long-term performance of companies and is an area of significant concern;

measures to increase the connection between boards of directors and other groups with an interest in corporate performance such as employees and small suppliers; and

whether, to what extent, and how, corporate governance requirements for listed companies should be extended to large privately held companies.

Votes on executive pay

Whilst quoted companies1 are already required to subject their pay policy to a binding vote every three years and their annual pay awards to an annual advisory vote, BEIS suggests that shareholders in listed companies could have a binding vote on all or some elements of executive pay packages - this could lead to executive pay packages potentially being blocked by shareholders. Options for consideration raised in the Green Paper include:

a requirement to set upper thresholds for total annual pay and a binding vote at the AGM where actual pay exceeds that threshold;

a requirement to have binding votes more frequently than every three years or to allow shareholders to bring these votes forward; and

a strengthening of the existing UK Corporate Governance Code so it is more specific on how to meet obligations to shareholders when deciding on remuneration.

Shareholder engagement with executive pay

The Green Paper suggests that there should be a focus on encouraging greater shareholder engagement with executive pay, since shareholders have rejected pay packages only in a very small number of cases, usually where outcomes have clearly been out of line with performance, and a significant percentage of shareholder votes are not used at all. The options that BEIS sets out for consideration in the Green Paper include:

mandatory disclosure of fund managers’ voting records instead of the current UK Stewardship Code advice to do so;

establishing a senior shareholder committee to engage with executive remuneration arrangements; and

encouraging individual retail shareholders (who can have perspective and views on corporate issues that are different from those of professional, institutional investors) to exercise their rights to vote on pay and other corporate decisions.

The role of remuneration committees

BEIS suggests strengthening the role of remuneration committees and improving engagement between them and shareholders and employees. Options for achieving this set out in the Green Paper include requiring:

the remuneration committee to take into account the views of the wider company workforce and shareholders before it makes recommendations on executive pay; and

the chairs of remuneration committees to have been on the remuneration committee for 12 months before they become chair to improve their understanding of the company before taking up the role of chair.

Transparency in executive pay

The Green Paper discusses whether transparency in executive pay could be improved through pay ratio reporting - requiring companies to publish the ratio between the pay of the CEO and the median salary. This could assist shareholders, employees and the wider public in assessing how executive pay compares across different companies, particularly those in the same sector, and would allow comparison within the same company over time. Pay ratio reporting would also allow boards to explain why the ratio is appropriate given the business’s performance. The Green Paper goes on to note the counterargument - that pay ratios would represent a new reporting obligation which would add little of value in helping to set appropriate pay levels and could produce misleading results which could be misunderstood or misconstrued.

Another suggestion to be considered is to require greater disclosure of the performance targets that trigger annual bonuses and benefits under long term incentive plans. Should non-legislative pressure on companies to provide full disclosure be increased through the Investment Association (and others) or strengthening the UK Corporate Governance Code? Or should retrospective disclosure of all bonus targets within a specified timeframe become a formal reporting requirement? The Green Paper does acknowledge, however, that there may be legitimate cases for non-disclosure if it could harm companies’ commercial prospects.

Long-term executive pay incentives

BEIS suggests there is some doubt as to how effective current remuneration arrangements are at incentivising long-term performance. The paper floats two suggestions to increase the effectiveness of long term incentives:

considering the use of restricted share awards as an alternative to LTIPs: executives would be awarded annual share options that could be exercised at some point in the future based on continued employment (without the complicated performance criteria currently found in LTIPS), combined with a requirement for executives to keep their share awards until they have built up twice their gross salary, in order to encourage long-term value creation; and/or

extending exercise/holding periods for share options/LTIPs to at least 5 years rather than 3 years, in an attempt to reduce short-term behaviour.

Strengthening employee, customer and wider stakeholder voice

Various options are raised for addressing how the influence and voice of employees, customer and wider stakeholders can be strengthened in relation to corporate governance. Options raised in the Green Paper include:

the establishment of stakeholder advisory panels, so that directors can hear directly from employees and other stakeholders - advisory panel members to board meetings where relevant. BEIS says this would offer transparency in a way that is flexible and could change depending on the issues facing a company at a particular time;

designating existing non-executive directors to ensure that voices of interested groups, particularly those of employees, are heard at board level. Whilst this would facilitate the views of employees and of other key interested groups being heard without adding to boardroom size, BEIS does concede that NEDs would be constrained by their directors’ duties, and that the designation of one particular director as having a role in that regard might result in other board members taking less of an active interest in issues affecting employees and other stakeholders;

appointing individual stakeholder representatives to company boards, to add a new perspective directly to the board. BEIS highlights certain disadvantages, such as conflicts in discussion, and an employee who sits on the board being constrained by directors’ duties. The Green Paper makes clear that this is not an option that the Government would propose to mandate; and

strengthening reporting requirements related to stakeholder engagement. Making the current reporting requirements more specific would result in wider awareness of directors’ duties and how stakeholder interests are dealt with during boardroom discussions.

Corporate governance in large, privately-held businesses

Currently public companies are the focus of the UK’s strongest corporate governance standards. Many large businesses are privately owned companies or LLPs (the Green Paper notes there are approximately 2,500 private companies and 90 LLPs with more than 1,000 employees), and these are not required to meet the same standards. BEIS wishes to consider applying enhanced standards of corporate governance more widely potentially by way of:

requiring large private companies to abide by the FRC's Corporate Governance Code which currently only applies to listed companies; or

the creation of a bespoke code of practice for large private companies (the Government seeks views on where any size threshold should be set)

Conclusion

In her introduction to the Green Paper the Prime Minister makes clear that big business must “earn and keep the trust and confidence of their customers, employees and the wider public” and that the “behaviour of a limited few has damaged the reputation of the many”. The Green Paper sets out a number of significant potential changes to the UK’s corporate government architecture. The the deadline for responses is 17 February 2017 and we will issue further updates as and when formal proposals for reform are issued.

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